Macy’s Will Extend Its Remarkable Run in 2014

For 2,500 Macy's (M 2.09%) employees, the new year is anything but happy after the giant department-store chain announced that it was going to cut that many jobs this year and save about $100 million every year in the process. For Macy's investors, however, the news was sweet music to their ears, and they bid up the shares by 7.8%; at one point the stock hit an all-time high of $56.12. The job cuts and consequential cost savings will significantly improve Macy's bottom line in fiscal 2014, from $4.32 per share to a range of $4.40 -$4.50 per share. The company will cut about three employees at each of its 800 stores.

Macy's shareholders were also happy that the retailer's holiday sales were significantly better than the performance at rivals Nordstrom, Kohl's (KSS -1.91%), and Dillard's (DDS 0.63%). Macy's same-store sales for both November and December rose a healthy 4.3% compared to last year's 3.6%. That was quite an achievement since only a few retailers, such as discount store Costco Wholesale (COST 1.57%), with same-store sales growth of 3% for the holiday season, could manage to smile about Christmas sales.

Macy's Bloomingdale's business did well during the holidays after the company offered modest discounts to its customers without sacrificing profit margin. That's important for Macy's since the company commands the best gross margin in the industry.

Macy's expects its fourth-quarter 2013 same-store sales to grow by 2.3%-2.5%, better than earlier estimates of 2.2%-2.3%. The company has been thriving under the watchful eye of CEO Terry Lundgren and has been steadily growing its profits by adding competitively-priced exclusive merchandise. It has also allowed lower-level managers to customize their local-store assortments to match local-customer tastes and preferences. But the company's online sales are perhaps the best part of the story.

Of the four peers, only Dillard's earning's growth outperformed Macy's:

Macy's omnichannel sales approach paying off
Macy's strong holiday sales can be pinned on its robust e-commerce platform and its omnichannel selling approach. Using this novel sales strategy, Macy's 500 stores were chosen as substitutes for its distribution centers and handled most of the fulfillment. These stores played a critical role in expediting the delivery process to customers.

The company's online sales were also instrumental in stemming the negative effects of inclement weather in the north and south. Customers who could not leave their homes to go shopping at Macy's physical stores could still rely on the retailer's online stores and the company's ability to fulfill customer orders locally.

Many consumers view Macy's merchandise as fairly priced, with a healthy mix of mid- and high-end brands; that contrasts quite sharply with Nordstrom's predominantly high-end and pricey merchandise. Macy's also has a large selection of private labels. Here you can find brands such as Michael Kors, INC, Nautica, and Ralph Lauren. Private labels sport much higher gross margins than their national brethren, sometimes by as much as 400-500 basis points. This quite naturally helps to boost Macy's gross margin.

Why are its peers not doing quite as well?
Meanwhile, many of Macy's peers do not seem to be enjoying good times lately. Close competitor Nordstrom recently low-balled the high end of its full-year sales growth forecast from 3% to 2.5%. Its shares underperformed the broader S&P 500 in 2013 after gaining only 13%. However, that is likely to change in 2014 after the haute couture retailer moved to ramp up its popular multichannel sales strategy by opening a new Rack website that is entirely dedicated to The Rack. It also plans to open at least 90 new Rack stores to shore the number to 230 from the current 141. Rack stores are very productive and average $525 per square foot compared to the industry average of $300 per square foot.

Kohl's seems to be dogged by problems of inventory imbalances and general lackluster merchandising. The company has been accused of failing to meet customer demands and ignoring national brands. Although national brands are not as profitable as private labels, they are nevertheless important for driving store traffic. Kohl's is working hard to woo national brands and has already introduced new national brands to its portfolio such as IZOD and Juicy Couture. Its inventory levels have also been falling to more desirable levels.

Dillard's gross margin has been steadily improving over the years. Its revenue growth is somewhere mid-range between industry peers Kohl's on the lower end and Nordstrom on the higher end.

Its shares are also considerably cheaper than its peers. With a P/E ratio of 12.3 for the trailing-12 months, shares are cheaper than most of Kohl's peers, which have an average P/E of 16.

That Dillard shares are still so cheap is quite surprising bearing in mind the stock's phenomenal rise over the past five years -- the stock has been an 18-bagger!

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Discount stores such as Costco are benefiting from the secular trend of widespread bargain hunting in US retail stores. Costco marks up its products by just 15%, and the strategy has been paying off handsomely; its same-store sales grew at an average of 5% in the first three quarters of 2013. The company has also been recording phenomenal growth in its membership, with 1.6 million new members signing up in the first half of 2013. The company's ancillary businesses and private labels have been contributing to its top-line growth in a big way, with ancillary businesses accounting for 20% of Costco's overall revenue.

Foolish bottom line
Macy's is roaring at a time when many of its peers are struggling. Although trading at a forward P/E of 19 hardly makes the shares prime candidates for the bargain bin, the fact that the retailer has preserved the integrity of its gross margin in a backdrop of a tough retail environment is a sure sign of an astute management team. The shares are a great investment.